The Tilt Effect Revisited. Inflation and Housing Recessions

The tilt effect was broadly studied in the 1970s and early 1980s, when inflation rates were rising rapidly and even reached the double digits, but scholars seemed to lose interest as inflation rates declined and central banks committed to price stability. However, the tilt effect is harmful even in low inflation environments and, with any increase, it can bring about to all the typical features of a housing recession: a fall in demand and prices due to the tilt-demand effect, and an increase in defaults and foreclosures due to the tilt-liquidity effect. Using a model to study the US housing market between 1969 and 2021, we find that increases in inflation, nominal interest rates and the tilt effect burden preceded all housing recessions. We focus on the 2007 housing recession and put forward that the model explains the fall in sales and prices, the increase in ARM borrowers’ defaults and some of the FRM lenders losses. It also explains why prices rose in 2021, despite the 2020 economic recession. We can interpret the tilt effect as a liquidity problem, as it changes borrowers’ real stream of loan payments, but also as a variation in real interest rates that hurts housing markets and the economy. Tilt-effect-induced problems can be avoided by having zero inflation, improving market liquidity or granting inflation-indexed loans. However, only this last option can prevent the main setbacks in all scenarios reducing financial risk and costs, while contributing to improve economic and financial stability, to reduce housing market volatility for lenders, borrowers and real estate agents, and to increase homeownership